Move Over VIX (VXX): A Better Way to Measure Volatility?

ETF Database

Nov. 19, 2013, 7:00 AM

The S&P 500 VIX Short-Term Futures ETN (VXX, A-) debuted in early 2009 and has been one of the most polarizing funds ever since. Tracking futures on the VIX, which is often dubbed "The Fear Index," VXX has offered traders hefty volatility and the potential for significant gains (or losses). Trading an average of 13.2 million shares each day, VXX is one of the most traded ETFs in the world. Now, a firm called NationShares, believes it has developed a better way for investors to track volatility and the firm plans to release an ETF that looks to compete with VXX [for more ETF news and analysis subscribe to our free newsletter].

How the VIX and VXX Work

The VIX gets its fear-related nickname due to the fact that it tracks the implied volatility of the S&P 500 (SPX). It does this by measuring the price of options on the SPX, including those that are way out-of-the-money on both sides, creating something of a disconnect for how options traders actually look at implied volatility.

Another issue with tracking options on the S&P 500 itself is that there is not a healthy amount of liquidity; bid-ask spreads often get out of whack and can make trading a headache. Investors will also note that SPX options trade on just one exchange. All of these factors combine to bring options and futures that are often way off from the levels that the VIX is actually trading at; that is, the options and futures you can purchase are often significantly higher or lower than the actual price of the VIX [see also The 10 Worst ETF Trades of All Time].

VXX invests in front and second-month futures contracts on the VIX, subjecting it to all of the issues that plague the index itself. While VXX can do a fine job of reflecting volatility on certain trading days, there are others where it seems like the ETF and its underlying index are not quite in line with how many traders perceive volatility.

Enter NationShares, a company looking to bring investors a better way to measure volatility with its new VolDex Index.

A New Way to Track Volatility

The Nations VolDex measures broad market implied volatility by way of at-the-money SPDR S&P 500 ETF (SPY, A) options. While some may be question how the ETF could be a better option than the index itself, consider the following: SPY has the most liquid options in the world, far more than its underlying index. The ETF trades on nearly every exchange in the country and maintains very healthy, one or two penny spreads.

Also, by tracking at-the-money-options, futures and options, the VolDex will more closely match the index's price, closing the gap that often plagues VIX futures. For now, the VolDex exists as just an index, but the company plans to roll out an ETF as soon as Q1 2014. Volatility products have been relatively popular out of the gate in recent years, boding well for the prospective fund's launch. The real question will be how well investors will adopt the new measure of volatility and if they will be willing to look beyond VXX, which has been a staple of the volatility world for nearly five years.